An empirical investigation of the twin deficit hypothesis: Panel evidence from selected Asian economies

Abstract

The paper examines the twin deficit hypothesis for a panel of eight South Asian and South East Asian economies having a history of persistent deficits on both fiscal and current accounts for the period 1985-2014. The results based on first and second generation panel cointegration tests indicate existence of a long-run relationship among budget balance, interest rate, exchange rate and current account balance. The estimates of long run coefficients obtained from common correlated effects mean group indicate a positive relationship between the two balances, the impact of the budget balance on the current account being stronger. Dumitrescu-Hurlin panel causality and block exogeniety tests suggest a feedback relationship between the two balances. The conventional hypothesis of causation running from budget balance to interest rates, to exchange rates and then to current account balance is however not borne out by the results.